Handbook on the Economics of Foreign Aid
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Handbook on the Economics of Foreign Aid

Edited by B. Mak Arvin and Byron Lew

It would be fair to say that foreign aid today is one of the most important factors in international relations and in the national economy of many countries – as well as one of the most researched fields in economics. Although much has been written on the subject of foreign aid, this book contributes by taking stock of knowledge in the field, with chapters summarizing long-standing debates as well as the latest advances. Several contributions provide new analytical insights or empirical evidence on different aspects of aid. As a whole, the book demonstrate how researchers have dealt with increasingly complex issues over time – both theoretical and empirical – on the allocation, impact, and efficacy of aid, with aid policies placed at the center of the discussion.
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Chapter 15: Foreign aid, economic growth, FDI, and trade openness in lower middle-income countries: a dynamic panel data analysis

Rudra Pradhan and B. Mak Arvin


A primary objective of foreign aid is to foster economic development. Although economic development does not always mean economic growth, there has been much theoretical debate, especially since the 1960s, about whether aid has a positive impact on the economic growth of the developing countries. Most of the earlier empirical studies supply inconclusive results. Mosley (1980) discusses the econometric flaws in these studies. More recent studies include Mosley (1997), who demonstrates that the net impact of aid is neutral overall, positive in most of the Asian countries, and negative in most of the African nations. This is consistent with Hansen and Tarp’s (2000) finding that aid impacts on economic growth, as long as the aid to gross domestic product ratio is not excessively high. According to two other studies (Collier and Dollar, 2002; Lensink and White, 2001), above a certain level, aid has a pernicious impact on the growth rate of a recipient country. The two studies, however, find different critical levels. On the other hand, Guillaumont and Chauvet (2001) maintain that the effectiveness of aid depends much more upon external factors (for example, export instability and terms-of-trade fluctuations) and climatic factors (for example, droughts, flood, and earthquakes) than on the economic environment. Specifically, they argue that aid is more effective in raising a recipient country’s income when external and climatic factors are worse. An influential book by World Bank (1998) provoked particular interest in the question of aid effectiveness.

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